Tuesday, July 25, 2017

The Hassett-Laffer Curve and that Norwegian Outlier

My earlier post needs a better title and a clear reason why Norway’s corporate profits were near 10% of its GDP even as it had a lower statutory corporate profits tax rate than nations like Australia or the U.S. Mark Thoma calls Norway an outlier:

Since it looks like all that's been done here is to draw a line through an outlier, Norway … I haven't actually run the regression, but it looks clear to me that revenues rise with tax rates, and the fit also looks better than in the first graph. Toss out Norway, and the fit looks even better

But we can do better when we realize that the statutory tax rate often fails to capture the totality of how profits are taxed in any particular nation. KPMG provides corporate profits tax rates by nation over the 2003 to 2017 period by nation with footnotes such as this one for Norway:

Special rules may apply petroleum companies and in the power sector

Let’s compare two nations: A and N. A has a statutory rate = 30% but allows half of its profits be sourced in tax havens. N has a statutory rate = 28% but has no tax haven profits. Instead it applies a 78% tax rate on petroleum and power sector companies. Oliver Milman notes:

Norway’s oil piggy bank is worth more than the GDP of Switzerland. More even than the US’ gargantuan annual military budget .... In Norway, companies drilling for North Sea oil pay a 78% tax rate on income, compared with a corporate tax rate of 28%... By contrast, the much-derided Minerals Resource Rent Tax placed a 22.5% “super profits” tax on coal and iron ore producers. But the nature of the system meant that it raised very little money. But the nature of the system meant that it raised very little money. Indeed, last financial year it raised nothing at all and was projected to bring in just $450m this year. This kind of flaw isn’t that surprising when, uniquely among businesses, the mining companies were allowed to write their own tax code by a callow Labor government terrified of marauding mining magnates on the back of Utes.

Let’s assume both nations have profit to GDP ratios equal to 30% but different tax rules. A would be expected to collect taxes equal to only 4.5% of GDP but N would likely collect taxes equal to 9.9% if 3% of its GDP faces this 78% tax. As our simple model explains the Norwegian outlier – you might protest I’m being unfair to Australia as their profit tax/GDP ratio was 6% not 4.5%. You see the Australians have been more aggressive at closing loopholes and enforcing transfer pricing. A is actually America as the U.S. allows for things like REITs and S corporations and has a weaker record of enforcing transfer pricing. Wasn’t this what this Angrybear post?:

First – if you are wondering why the US rate is 39.3% rather than 35% – think state income taxes. Of course, US corporations often don’t pay a 4.3% effective state tax rate as tax planning plays such as Delaware Intangible Holding Companies (can your say transfer pricing) allow opportunities to lower this effective tax rate. At the Federal level, US corporations used to have that FISC/EIE game and now have a Section 199 game. So if you tax director has you stuck with a 39.3% effective tax rate – fire him now. That Swiss rate of 21.3% might look low but it is not as low as the 12.5% Irish rate. So why are so many US based companies shifting intangible profits to Switzerland rather than Ireland? Could it be that the Swiss Federal rate is only 8.5%? The alleged 21.3% rate contains a high local government rate. Only thing is that a lot of companies are located in the Swiss equivalent of Delaware. Also note that the Mexican corporate profits tax is lower than the US rate. So why do many companies try to source more income in the US and less in Mexico (can you say transfer pricing again). It seems that the Mexican government imposes a tax on profits to pay for their version of Social Security. The WSJ’s amateurish graphs and all the regressions in the world are not that impressive unless one addresses two matters. The first matter is the above concern regarding measuring effective tax rates.

Bottom line –these regressions (or phony curves) across nations with different tax systems can be misleading. But note Norway lowered its tax rates to 24% overall and 74% on oil profits so if our model is right, their tax/GDP ratio should drop to 8.7%. Time will tell!

1 comment:

This is partially true in the US as well. In the national income and product accounts, the Federal Reserve is treated as a private company in the banking sector that pays a 100% tax rate because all its net profits are repatriated to the Treasury. This raises the effective corporate tax rate.